March 25 (Bloomberg) -- European Union leaders cut the
startup capital for the future euro emergency aid mechanism
after German demands to make smaller upfront payments stoked
fresh concerns about Europe’s effort to quell the debt crisis.

As speculation swirled that Portugal will be the next
victim of the crisis, the leaders bowed to German Chancellor
Angela Merkel’s call to pare the fund’s paid-in capital as of
2013 to 16 billion euros ($23 billion), less than the 40 billion
euros foreseen in a March 21 accord.

“It was a difficult debate with Germany,” Luxembourg
Prime Minister Jean-Claude Juncker told reporters after the
first session of an EU summit in Brussels early today. “Germany
found that in the compromise agreed last Monday it would have to
pay in too much. So we had to tackle that issue.”

With Merkel’s party trailing an opposition bloc in the
polls before a March 27 regional election, the sparring over the
future emergency support system reflected domestic political
pressure on leaders in Europe’s wealthier north to limit aid to
struggling southern economies.

Merkel’s renegotiation of the three-day-old financing
accord punctured the EU’s proclamation of a “comprehensive”
anti-crisis strategy, including tougher sanctions on excessive
budget deficits and national pledges to increase
competitiveness.

Debt-Swamped States

German political jitters over propping up debt-swamped
states dominated the crisis response last year, with Merkel
delaying aid for Greece and calling for bondholder losses that
hastened Ireland’s plunge into the fiscal abyss.

Portugal, for example, navigates the next phase of the
crisis with the government’s powers in doubt after the defeat of
a budget-cutting plan in parliament on March 23 led Prime
Minister Jose Socrates to offer to step down.

Downgrades by Fitch Ratings and Standard & Poor’s dealt a
further blow yesterday, as EU leaders called on Socrates and the
opposition parties to unite behind belt-tightening measures that
might spare Portugal from becoming the third euro country to tap
emergency aid.

Standard & Poor’s might take struggling countries down
another notch, since the future fund -- known as the European
Stability Mechanism -- will outrank private bondholders, said
Moritz Kraemer, managing director of European sovereign ratings
in Frankfurt.

Ratings Reassessment

“We would reassess the ratings specifically of Greece and
Portugal, which we think are the most likely potential customers
of the ESM,” Kraemer said on Bloomberg Television today.

Portuguese bonds fell for a fourth day today, pushing the
10-year yield up 13 basis points to 7.79 percent. The extra
yield over German bonds, a sign of the risk of investing in
Portugal, rose 10 basis points to 452 basis points.

Socrates “made it clear in the most likely case that there
will soon be elections in Portugal, he’s sure that whatever will
be the next government all the commitments in terms of fiscal
targets will be respected,” said European Commission President
Jose Barroso, a former Portuguese leader.

Portugal continued to rule out a bailout, which two
officials with direct knowledge of the matter said may total
between 50 billion euros and 70 billion euros.

Split in Alliance

The German move on the emergency fund split the six-country
alliance of AAA-rated countries that shoulder the bulk of the
rescue costs. Political sensitivity is high in Finland, part of
the top-rated club, where polls show a surge in support for an
anti-euro party in the run-up to April 17 elections.

Finnish Prime Minister Mari Kiviniemi told Bloomberg
Television before the summit that she would oppose a deal that
“increases any country’s responsibilities.”

Cash contributions to the future fund will amount to 80
billion euros spread over five equal annual installments.
Another 620 billion euros will be callable, to give the fund an
AAA rating with a lending capacity of 500 billion euros.

Isolated in the summit debate, Germany accepted a provision
enabling the fund to make up any capital shortfalls during the
startup phase by requiring euro governments to accelerate
contributions of cash or “appropriate instruments” such as
bonds to maintain a lending buffer.

The revised financing arrangements are unlikely to
jeopardize the goal of an AAA rating for the fund, said Silvio
Peruzzo, an analyst at Royal Bank of Scotland Group Plc.

“They made it quite clear that it’s absolutely important
to them to make sure the rating of this vehicle is AAA,”
Peruzzo said. Germany is “the biggest player and they’ve got
the most cash and they’ve imposed most of the conditions.”

While leaders renewed a pledge to bring the firepower of
the current temporary rescue fund up to a planned 440 billion
euros by June, they didn’t spell out how that will be done. Set
up at the height of the Greek phase of the crisis last year,
that fund is limited by collateral rules to lending only 250
billion euros.